Hi Mark, Hello Allan,
I have this scenario for covered call using LEAPS: XYZ stocks is $98 today
I buy Jan 2010 50 LEAPS call for $48 This is a very unreasonable price. There is no time
premium in this option, and your suggest buy price is parity. With
expiration so far in the future, it's impossible to buy this option at
this low price. NOTE: When determining your potential price, never look
at 'last sale' - look at the current bid and ask prices.
I sell Jun 100 call for $8
According to CBOE website, in the event the stock runs up past the short 100 call strike and you are assigned, you can do one of the following:
1)Go into the market to purchase the stock for delivery
2)Sell your LEAPS back and use the proceeds to help with the purchase of the stock to deliver
3)Exercise your LEAPS at 50 and deliver the stock at 100
4) You can also do nothing and carry the stock short, using your LEAPS as a hedge. Do this only if bearish because the position is exactly equivalent to owning a Jan 2010 50 put. You do well if the stock dips under 100 again. That would be when you buy back the stock and write another call option.
Among these 3 choices which is the cost effective to be use? Considering there is $X commission in buying/selling both stocks and LEAPS.
The worst choice is always
exercising the LEAPS. That's because it has residual time premium and
you lose that time premium when you exercise. Note that in your
example, the LEAPS is trading at parity and has zzero time premium. If
that situation were to really occur, then it would be okay to exercise.
Next best is to sell the LEAPS, buy the stock and have no remaining
A better choice is usually (assuming you still want to own LEAPS and
write calls against it) is to simply buy the stock and write a new call
But, the best choice - making the same assumption that you want to
continue to write against LEAPS - is to roll the positon just prior to
expiration. that means entering a spread (or combo) order to
repurchase the call you are short and simultaneoulsy selling a new
call. This way, you never have to deal with a stock position.
What are the pros & cons using CC using LEAPS vs. traditional CC?
The main advantage is risk
reduction. That's because the stock can drop significantly more than
the LEAPS option if the stock tumbles. Your example negates that
factor because you are buying a very deep in the money LEAPS. Most
people who believe in this method (I do not) choose less expensive
LEAPS options to buy.
A minor advantage is that owning LEAPS ties up less cash than owning
The major disadvantage - and it's a real disadvantage - is that a surge
in the stock price leaves you with a position that loses money as the
stock price increases. When you use CC, the upside NEVER hurts. You
make the maximum profit if assigned, and that's that. But a
LEAPSmincreases slightly less than point for point with the stock as
the stock price rises. The short call, being a near-term option
eventually rises point for point with the stock (delta 100) and thus,
you lose slightly more and more as the price rises. If truly bullish -
and you should be to write CC, then this is a risk.
Mark D. Wolfinger
The Rookie's Guide to Options:
The Beginner's Handbook of Trading Equity Options